CHAPTER 3 Forecasting

FORECAST: A statement about the future value of a variable of interest such as demand. Forecasts affect decisions and activities throughout an organization Accounting, finance Human resources Marketing MIS Operations Product / service design

Uses of Forecasts Accounting Cost/profit estimates Finance Cash flow and funding Human Resources Hiring/recruiting/training Marketing Pricing, promotion, strategy MIS IT/IS systems, services Operations Schedules, MRP, workloads Product/service design New products and services

Assumes causal system past ==> future Forecasts rarely perfect because of randomness Forecasts more accurate for groups vs. individuals Forecast accuracy decreases as time horizon increases I see that you will get an A this semester.

Elements of a Good Forecast Timely Accurate Reliable Meaningful Written Easy to use

Steps in the Forecasting Process Step 1 Determine purpose of forecast Step 2 Establish a time horizon Step 3 Select a forecasting technique Step 4 Gather and analyze data Step 5 Prepare the forecast Step 6 Monitor the forecast “The forecast”

Types of Forecasts Judgmental - uses subjective inputs Time series - uses historical data assuming the future will be like the past Associative models - uses explanatory variables to predict the future

Judgmental Forecasts Executive opinions Sales force opinions Consumer surveys Outside opinion Delphi method Opinions of managers and staff Achieves a consensus forecast

Time Series Forecasts Trend - long-term movement in data Seasonality - short-term regular variations in data Cycle – wavelike variations of more than one year’s duration Irregular variations - caused by unusual circumstances Random variations - caused by chance

Forecast Variations Figure 3.1 Trend Cycles Irregular variation 90 89 88 Seasonal variations

week.... Now, next week we should sell.... Naive Forecasts Uh, give me a minute.... We sold 250 wheels last week.... Now, next week we should sell.... The forecast for any period equals the previous period’s actual value.

Techniques for Averaging Moving average Weighted moving average Exponential smoothing

MAn = n Ai  Moving Averages Moving average – A technique that averages a number of recent actual values, updated as new values become available. Weighted moving average – More recent values in a series are given more weight in computing the forecast. MAn = n Ai i = 1 

Simple Moving Average Actual MA5 MA3 MAn = n Ai i = 1 

Exponential Smoothing Ft = Ft-1 + (At-1 - Ft-1) Premise--The most recent observations might have the highest predictive value. Therefore, we should give more weight to the more recent time periods when forecasting.

Exponential Smoothing Ft = Ft-1 + (At-1 - Ft-1) Weighted averaging method based on previous forecast plus a percentage of the forecast error A-F is the error term,  is the % feedback

Example 3 - Exponential Smoothing

Picking a Smoothing Constant  .1 .4 Actual

Associative Forecasting Predictor variables - used to predict values of variable interest Regression - technique for fitting a line to a set of points Least squares line - minimizes sum of squared deviations around the line

Linear Model Seems Reasonable Computed relationship A straight line is fitted to a set of sample points.

Forecast Accuracy Error - difference between actual value and predicted value Mean Absolute Deviation (MAD) Average absolute error Mean Squared Error (MSE) Average of squared error Mean Absolute Percent Error (MAPE) Average absolute percent error

MAD, MSE, and MAPE  Actual  forecast MAD = n MSE = Actual forecast) - 1 2   n ( MAPE = Actual forecast  n / Actual*100) (

Example 10

Choosing a Forecasting Technique No single technique works in every situation Two most important factors Cost Accuracy Other factors include the availability of: Historical data Computers Time needed to gather and analyze the data Forecast horizon

Exponential Smoothing

Linear Trend Equation

Simple Linear Regression

United Airlines example Workload/Scheduling SSU9 United Airlines example